A dividend rush before fiscal cliff fall

Rob Varnon

Published 9:09 pm, Friday, November 30, 2012

U.S. corporations, which together are sitting on $2.2 trillion in cash, are deciding whether to reward investors with special dividends before taxes increase at the end of the year or to hold funds should President Barack Obama and Congress fail to come to a budget agreement.

Congress and Obama began negotiations on a new budget agreement this week aimed at avoiding the so-called fiscal cliff, which will cut nearly $1 trillion in federal spending over 10 years and raise taxes.

If no deal is reached, several experts have predicted the nation will fall into another recession. How corporations choose to deploy their cash in the coming months has significant implications for investors, the economy and the job market, according to experts.

Some companies, including several in Connecticut, have granted special dividends, using the cash they've built up over the last few years to reward investors. Fairfield-based Sturm Ruger, for example, will provide a special $4.50 dividend payable this month, joining Ethan Allen Interiors of Danbury, which said it will pay a special 49-cent dividend this month.

"Clearly, what people are trying to do is to get as much income this year, so they can benefit from the rates today before they go to whatever the rate is going to be," said Christopher Gallo, owner of Christopher Gallo CPA of Shelton.

The tax rate on dividends now is 15 percent, equivalent to the second lowest income tax rate paid by married couples making between $17,000 and $69,000 a year, according to the Tax Foundation, a Washington-based research institution.

"It's a nice little holiday present," said Joseph Mathews, first vice president and manager of Morgan Stanley's Fairfield office. But, Mathews cautioned, if a special dividend is used to augment the regular dividend, investors could expect that to continue in future years.

Mathews said it's time U.S. corporations started doing something with their cash, which has grown from $1.5 trillion on corporate balance sheets to $2.2 trillion in the last five years. He said some companies are increasing buyback programs or using the funds for mergers and acquisitions.

Bridgeport-based People's United Financial's board of directors last week authorized the bank to buy up to 33.6 million shares, financed using cash on hand and the proceeds from one or more debt financings.

Mathew Breese, an analyst with Sterne Agee, said larger regional banks like People's aren't likely to issue special dividends because regulators scrutinize how these banks deploy their capital. Other economists have noted the regulators are also forcing banks to build reserves.

Certain industries are going to see profits challenged in the coming years, especially pharmaceuticals that make name-brand drugs, Mathews and other analysts say. Under the new health-care law, there is an expectation that generic drug makers will profit at the expense of name-brand manufacturers.

Pfizer listed $4.5 billion in cash at the end of September, an increase of 21 percent over a year ago.

"Companies are drawing back and are being very careful and are waiting to see what happens," said Philip Finnegan, director of corporate analysis at defense and aerospace analysis firm the Teal Group.

He did not expect defense companies to do much with dividends heading into 2013 because of larger economic concerns ranging from Pentagon spending cuts to the European debt crisis.

Defense companies overall have been building reserves, with Bloomberg News reporting the top five defense contractors in the nation, including Lockheed Martin, increasing their average cash holdings by 71 percent to $4.13 billion in the third quarter of 2012 compared with two years ago.

In Connecticut, Hartford-based United Technologies, the parent company of Sikorsky Aircraft and jet engine maker Pratt & Whitney, was carrying $6.2 billion in cash as of Sept. 30, an increase of 4.5 percent from a year ago, despite acquiring Goodrich for $16.5 billion.

General Electric, based in Fairfield, affirmed Friday a plan to use $100 billion in cash over the next few years for acquisitions and stock buybacks, to increase its regular dividend in line with earnings and for operating expenses.

While many companies are preparing for the worst, some, like UIL Holdings in New Haven, are actively campaigning to stop a tax hike on dividends.

Michael West, a UIL spokesman, said the dividend tax rate is a reason utilities are able to attract investors in this economy.

"Most people invest in our sort of stock because of the stability and return on investment," West said. "And our return on investment is about 5 percent annually. If you start increasing the tax rate on that, it makes the stock less attractive."